Niklas Blanchard was an early supporter of market monetarist ideas, but then stepped away from blogging. I’m happy to report that he’s back with an excellent post. Niklas criticizes Taylor’s claim that interest rate targeting is like a price control. Of course it isn’t. I have to believe it was just a slip by Taylor, as he surely must know how the Fed targets interest rates via adjustments in the supply of reserves.

Here’s Niklas:

This makes very little sense given the fact that the Fed is shifting demand for assets. By buying assets now, and promising to buy them in the future, the Fed is directly influencing the demand for the assets that it buys. Taylor is claiming that the Fed is providing a cap on returns on holding assets. Taylor’s analogy says that this policy is like the government mandating that everyone get a flu shot (would would cause shortages of flu shots), when the proper analogy would be that the government is providing inoculations in order to keep the price low.

Perversely, it is the lack of forward guidance that Taylor seems to be seeking that necessitated the moves in the Fed’s balance sheet that Taylor is now worried about. Had the Fed been providing forward guidance the whole time (for instance, a target for the level of NGDP), it is more likely that NGDP would have remained stable throughout this entire period, and that the Fed’s balance sheet would be a fraction of the size it is today, and presumably we would not be having this conversation.

The Fed says that it wants to keep interest rates low for a long time, but subject to the constraint that inflation remain on target.

If people believe that inflation won’t be allowed to rise, the increase in the quantity of money that will be used to push down interest rates must be temporary.

Temporary increases in the quantity of money aren’t inflationary.

Can such increases push down interest rates? I think so. The way temporary increases in the quantity of money don’t cause more inflation is people hold the additional money. But does that mean they don’t substitute into short term bonds too?

Now, if the Fed was increasing the quantity of money and was going to let inflation adjust consistent with a given increase in the quantity of money, then the higher inflation rate would tend to raise nominal interest rates. Any temporary liquidity effect would have to be balanced by a longer term Fisher effect.

But the Fed isn’t allowing inflation to adjust.

Of course, the Fed is trying to get the output gap to close too. And the resulting increase in real output tends to raise real and nominal interest rates. But if the output gap will only close with more rapid inflation, and the Fed won’t let that happen, it would seem to me that the result of the quantitative easing is persistent liquidity effects.

Dang, I came here to post something similar to what Woolsey said. Beat me to it. I was going to say: Given a constant NGDP growth promise, or given a constant price inflation rate target promise, how does the Fed raise and lower interest rates?

The Fed lowers rates by increasing reserves, and it increases interest rates by decreasing reserves. So within a context of the market believing the Fed is going to prevent undue NGDP growth or undue price inflation growth, one can say that low interest rates really are a signal of easy money.

I offered a post a couple days ago arguing that interest rates do rise with easy money, but only on the side of an additional inflation premium, once the increase in the supply of money suffices, along with expectations that the Fed is going to allow price inflation to get out of hand (1970s), to make consumer prices rise.

For the stocks and TIPS spreads increasing on QE: TIPS spreads rose within the confines of the Fed’s historical inflation rate targeting, did they not? We didn’t see TIPS spreads signalling inflation expectation shift from 1% to something like 10%. No, we saw them shift below and around the 2% long term Fed target.

Suppose instead the Fed announced an even higher sized series of QEs, ones that can potentially make consumer prices rise 10%, IF the Fed also announced a higher price inflation target of 10%, but it doesn’t make that announcement because it wants to target 2%. I would think the market would still believe that the Fed would stick to its 2% price inflation target, and interest rates would be even lower, and TIPS spreads might have risen only a little higher.

I’m with Woolsey when he says he thinks Taylor is onto something. I think Woolsey’s argument, and mine, support Taylor. All the Fed’s monetary inflation since 2008 is not causing undue price inflation NOW, because the market still believes the Fed is going to maintain a target of 2% price inflation. But all that money has the POTENTIAL to create massive price inflation in the future. Just look at the velocity of M2 and MZM. They’re at extremely low levels.

Perhaps the way the Fed can actually bring about higher a NGDP is by simply announcing a credible target of 4% or 6% price inflation. There are more than enough reserves to make it happen. Maybe the whole reason velocity is at super lows, why interest rates are at super lows, and why we should be concerned about the quantity of money that now exists, is that the Fed is still seen as targeting price inflation of 2%. In this context, the low interest rates might very well reflect very easy money…that just hasn’t manifested in price inflation, or NGDP because of the Fed’s promise.

This is something people often seem to forget about bubbles — they generally don’t happen simply because there is more demand for as asset class, they happen because the future expectations of value for that asset class keep increasing. Remember those crazy dot-com revenue projections in 1999? You had companies whose combined valuations suggested their revenue would exceed the entire global economy by 2010! And in 2005 everyone thought house prices would go up forever — the conventional wisdom was “buy as much house as you can afford because that house will be too expensive for you in a few years.” There was similar logic at play in other bubbles, such as the early 30th electric bubble.

So that’s a big reason why I support the Fed asset-buying — I think at some point in the not-too-distant future, the Fed will sell those assets, in order to manage expectations.

Ever consider the possibility that asset purchases by the Fed are a crucial ingredient in the formation/encouragement of bubbles?

For expectations of continuously rising house prices, are you saying that these expectations can arise, or be further encouraged, on the basis of no Fed asset purchases?

There is a correlation between the Fed bringing interest rates down(up), and interest rate sensitive assets rising(falling) in price.

Could the housing bubble have occurred without continuous Fed “support” in the form of Fed directed low interest rates and Fed supported endogenous credit issuance? Maybe there would have still have been some “foam”, but I doubt it would have gotten as bad as it did, if instead interest rates were 10% and credit issuance was more subdued.

(To be less cryptic, I only brought up bubbles to make the point that expectations often don’t get enough attention, and I expect the Fed will sell assets only after getting closer to something like NGDPLT — because expectations uber alles!)

Savers face a low rate of return on fixed assets because we just experienced the largest recession in postwar history

This is a point I’ve made before too — as a holder of long-term bonds, yes it’s true inflation scares me. You know what scares me even more? Another few decades of low-zero growth — it happened in Japan and it can happen here. I’d like my one-year-old to be able to earn income someday.

I’m sure we all noticed 4Q GDP was revised negative, we may be in a second recession now. I’m to the point where I almost hope we are, just to prod the Fed onto an NGDPLT path that will be better for everyone in the long run.

(To be less cryptic, I only brought up bubbles to make the point that expectations often don’t get enough attention, and I expect the Fed will sell assets only after getting closer to something like NGDPLT — because expectations uber alles!)

Savers face a low rate of return on fixed assets because we just experienced the largest recession in postwar history

This is a point I’ve made before too — as a holder of long-term bonds, yes it’s true inflation scares me. You know what scares me even more? Another few decades of low-zero growth — it happened in Japan and it can happen here. I’d like my one-year-old to be able to earn income someday.

I’m sure we all noticed 4Q GDP was revised negative, we may be in a second recession now. I’m to the point where I almost hope we are, just to prod the Fed onto an NGDPLT path that will be better for everyone in the long run.

Geoff, No, Taylor isn’t “onto something.” We’ve known all along that temporary monetary injections are not inflationary.

And your facts about Japan are not correct–their RGDP growth has been low ever since 1992, much lower than South Korea. Of course monetary policy is not the only reason, perhaps not even the primary reason.

“Geoff, No, Taylor isn’t “onto something.” We’ve known all along that temporary monetary injections are not inflationary.”

Sorry, but I don’t think you’re getting Taylor’s point. Even temporary liquidity injections do raise the prices of SOMETHING. Whether or not they show up later on as a higher price level or NGDP, is a different question (the one I think you’re considering when you say “inflationary”), and not the point I think Taylor is making, which has more to do with price increases within a context of low or stable price levels and/or NGDP.

Recall, Taylor wrote:

“At the very least, the policy creates a great deal of uncertainty. People recognize that the Fed will eventually have to reverse course. When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation.”

Clearly Taylor is saying that all these monetary injections have not yet raised the prices of consumer goods, because it’s still working to push up asset prices, but once it does reach consumer goods, then the Fed will, according to Taylor, have to tighten up. So the question is when will this happen? There is uncertainty about the when, and that is what I think Taylor is getting at. In a context of a target of 2% price inflation, the large scale OMOs the Fed has heretofore engaged in will eventually have to be reversed. Since not every investor earns his keep through consumer goods sales, they are faced with great uncertainty of when that which is currently increasing their returns, namely QE, will be reversed.

You say that by experience, temporary liquidity injections are not inflationary. Sure, but that’s only if you define inflationary as rising consumer prices and/or spending and only if we go by the Fed’s historical policy promises concerning price inflation.

If on the other hand we’re “in the meantime”, then temporary liquidity injections do raise the prices of goods, just not consumer goods. Goods like assets in the stages “before” the consumer goods stage. Stock prices can rise, bond prices can rise, asset prices can rise, before consumer goods prices rise. And then, right before the prior inflation hits consumer goods too much, the Fed tightens up, ends the loose liquidity injections, and brings about a new deflationary force in the asset stages again, which hampers growth and employment, which then leads to a re-ignition of loose money, and so on, in repetition, all while keeping in view long term price inflation of 2%.

That’s why we observe temporary liquidity injections as not being inflationary. It’s because, following Taylor, by the time consumer price inflation heats up, the Fed usually tightens back up. I would say that temporary liquidity injections not being inflationary is an illusion, masked by the Fed’s historical behavior of tightening up just before, or during, the time when consumer price inflation heats up too much due to past OMOs.

It is only when the Fed’s loose money keeps going, past the consumer price inflation heating up stage, like what we saw in the 1970s, will these “temporary” liquidity injections be “inflationary” as you define it, because then “temporary” became “until Volcker becomes Fed chief”.

But if the Fed promises 2% consumer price inflation, and it’s credible, then really all of the increase rates of OMOs would be “temporary”, meaning “until consumer price inflation heats up too much”, and so I think that’s why we have historically seen relatively wide fluctuations in the asset price stages, but relatively narrow fluctuations in the consumer price stage.

If temporary liquidity injections had no effect on ANY prices, then there would be no point to them and we would have to believe they don’t do anything to prices. In order for that to happen, OMO reserves must be hoarded by the banks, period.

We would have to believe that if a substantial enough quantity of the Fed’s monetary injections these past few years aren’t inflationary on the basis of their being temporary, then we would have to say that the Fed could have engaged in fewer temporary OMOs and it wouldn’t have made any difference to prices.

That seems very unlikely, because without those additional reserves, many banks would have went bankrupt, which would have definitely put downward pressure on prices. Thus, the existence of those reserves did affect prices, just not enough effect on consumer prices to turn them “inflationary” per your definition.

You even said it yourself in a prior post: The various QEs have positively affected stock prices. But we all know that the QEs are in large part “temporary.” So you agree that even temporary liquidity injections raise prices. Nobody said they have to raise consumer prices right away. People’s incomes have to rise first before they can spend more money on consumer goods and make higher prices find a profitable demand. That takes time.

“And your facts about Japan are not correct-their RGDP growth has been low ever since 1992, much lower than South Korea. Of course monetary policy is not the only reason, perhaps not even the primary reason.”

Excuse me, but I think my facts about Japan are correct…if we don’t look at RGDP, or GDP, or NGDP, and those types of statistics, which are all functions primarily of money and spending. Instead, I look to statistics that are more a function of real growth, such as real GDP per capita, or even better, real GDP per capita corrected for Japan’s purchasing power parity.

Yes, Japan has performed “badly” if we look at statistics that go up and down with nominal inflation and deflation, and we define higher nominal statistics as “good” and lower nominal statistics as “bad”. That’s what I think people are doing with RGDP. RGDP is more a measure of past levels of aggregate spending. How can that be a reliable statistic for tracking real growth? Despite having the word “real” in its name, it is really anything but.

If we look to more reliable statistics for real growth, then Japan has indeed performed better than South Korea (for 20 years, up until the financial crisis, which is my data set), as well as quite a few other countries (which by the way are not attacked as much, because their inflation rates are higher than Japan’s, and this has increased the statistics you’re looking at for answers about real growth).

RGDP is IMHO a garbage statistic for tracking real growth. Zimbabwe’s RGDP growth for example was very high during the latter stages of their inflationary experience. But they were dirt poor.

Can you share your calculations Geoff? I’m looking at GDP per capita measures on the OECD and World Bank sites. Both sites show significant South Korean outperformance regardless of the price level adjustment tool utilized.

I see this as showing Japan as having a greater real production than every country/region below it.

I think I goofed about Korea. I’m a dufus. If we look at only the dark blue regions, which I didn’t do at first but should have, then looking at the growth since 1987, then contrary to my initial claim, Korea has outperformed Japan.

But still, Japan’s growth since 1987 is larger than quite a number of more inflationary countries and regions. It looks like Japan, just barely, beat the OECD total.

With that alone, I don’t see how the rather vociferous claims that Japan’s economy is in the toilet are justified.

Also, as far as I can tell (and please correct me if I am wrong as it is obvious I can’t read charts worth a damn), Japan has had, since 1987, comparable real growth on par with Switzerland, the number 5 economy in the world. It looks like the two blue bars for those countries are virtually identical, and Switzerland started at a higher level in 1987. That would mean Switzerland is stagnating relative to Japan, and that Japan is overtaking Switzerland!

Most economists regard Switzerland as a relatively healthy growth region. If so, then they SHOULD include Japan. Don’t you agree?

How often are economists lambasting those countries for having lousy growth, relative to Japan? It’s not even close. Japan seems to be many economist’s favorite punching bag. Unjustified, as these figures show.

The following is speculation, but a possible reason why so many “serious people” are chastising Japan’s reluctance to inflate, is because Japan isn’t a place where lots of money can be made by the more special privilege groups who benefit the most with inflation.

For if Japan is understood as a country with strong growth on par with Switzerland, then that would constitute a world example of a country that has healthy growth WITHOUT high inflation. Can you imagine how many people therefore have a special interest in hiding and/or covering this up?

I don’t blame everyone who thinks Japan is in the toilet as having this incentive, because many simply go along with the flow of communications from influential people.

Those voices are some of the loudest and influential, which then trickles down to economists playing the game too, unbeknownst of the true motivation of selish interest. Many people have a selfish interest in intimidating Japan into more inflation, and are probably a little angry that they never got their lost equity back after the Japanese stock market collapse, and a little scared that Japan is growing at a good, average, competitive pace despite the mainstream theory that they shouldn’t.

For those who have an interest in spreading the message of 5% NGDP targeting, not saying who, there is also an incentive to interpret and communicate Japan as being in the crapper. For if Japan grows without the kind of inflation thought necessary, then what if other countries got the same idea? Oh no!

The growth slowdown in Japan has been much sharper than in other countries, your data, doesn’t address that issue. Japan’s GDP/person is well below US levels, and indeed has regressed (as a fraction of US levels) between 1992 and 2007. Japan has fallen behind Hong Kong, Singapore and Taiwan in PPP terms, and in a few years will fall behind South Korea.

I don’t think anyone in their right mind view Switzerland as a fast growing economy.

Could the housing bubble have occurred without continuous Fed “support” in the form of Fed directed low interest rates and Fed supported endogenous credit issuance?

It certainly could have been less bad without those factors, but the main issue was that (under both parties) government was very deliberately encouraging lenders to relax standards and hide risks — it’s easy to forget today that most people agreed these were good ideas in 2005, because they resulted in more people owning homes.

And as I pointed out to you last March when you were selling this same bunkum, using these same charts you cherry picked from Web searches but clearly didn’t understand, you are including US inflation in your Japanese growth there!

Those numbers you cite are “real GDP by PPP per capita in current dollars”. You are comparing Japan’s 1987 GDP in current 1987 dollars to Japan’s 2010 GDP in 2010 dollars. US inflation over 1987-2010 was 92% “” and that you of all people (!) still insist on counting 92% of US inflation in Japan’s GDP growth, to conclude it is “healthy” … the irony!

Of course you did tell me back then that you didn’t know how to make the inflation adjustment(!!) “” not that you’ve let it stop you from apparently repeating ever since these numbers that you admitted then you didn’t understand.

OK, so here’s how you do it the right way, for your future reference:

Go to the IMF WEO Database, October 2012. Not the old one. Look up for Japan, “Gross domestic product based on purchasing-power-parity (PPP) per capita GDP, Current international dollar” for say the last 20 years. And you get, “1991: 20,465.62; 2011: 34,748.15″³ “” the numbers you so happily build your church upon.

BUT … those are in current 1991 dollars and current 2011 dollars. So we have to remove US inflation from Japanese growth to get “real GDP at PPP per capita”. BLS.gov tells us that the US CPI over 1991 to 2011 rose from 100.00 to 165.15. Thus to get 1991 Japanese GDP in 2011 dollars (to compare to its 2011 GDP in 2011 dollars) we have to multiply by 1.6515.

Again, simple common sense tells you – well, should have told you “” that when the entire world including the Japanese(!) think the Japanese have been stuck in a long-lasting slump, but you think they haven’t been, *probably* the opinion that’s wrong about that is yours … so you might want to re-check your numbers!

Before today I haven’t read any of your comments for nine months, since I corrected you on this nonsense back then, due to your insistence on creating your own alternate world to live in. To see you today repeating the exact same thing, using the very same charts (always instead of actual numbers) that you still don’t understand even after they were explained to you … very impressive!
[UNQUOTE]

I think the argument is that inflation raises both sets of prices, just not at the same time. Asset prices tend to rise first, and then sometime later consumer prices rise after inflation has finally raised the incomes of those who purchase the most consumer goods.

This I think goes back to asset prices tending to fall more than consumer prices during busts: Asset prices rise more by inflation, initially, and by the time consumer prices are set to rise, the central bank usually puts on the monetary brakes, which makes history look like asset prices rising and falling relatively more than consumer prices.

“The growth slowdown in Japan has been much sharper than in other countries, your data, doesn’t address that issue.”

Nowhere close to all other countries. That’s my point. It wasn’t intended to show that Japan’s growth has been less than “other countries” in the rate of growth sense.

It was meant to show that the growth of Japan is on par, and exceeds, many other, more inflationary countries.

“Japan’s GDP/person is well below US levels, and indeed has regressed (as a fraction of US levels) between 1992 and 2007.”

Right. But they have always been well below US levels, and other more inflationary economies have also regressed (as a fraction of the US). They’re not alone in this respect.

“Japan has fallen behind Hong Kong, Singapore and Taiwan in PPP terms, and in a few years will fall behind South Korea.”

Right, but those countries happen to be relatively high growth regions. Japan has risen further above France, Portugal, OECD and a number of other countries/regions.

Listing those regions that have outperformed Japan is no more an argument against what I am saying, as is listing those regions that Japan has outperformed is an argument for what you think I am arguing against.

“I don’t think anyone in their right mind view Switzerland as a fast growing economy.”

I don’t think anyone in their right mind would call Switzerland in a lost decades, and yet they have had the same growth 1987 – 2007 as Japan, and they started out in 1987 at a higher level.

It seems to me, by the style and approach of your response, that it might be the case that you are minimizing the performance of Japan, unduly. Why? I don’t know, but I suspect it may have something to do with the fact that it has not been mired in the kind of depression and zero growth that perhaps it “should” be according to orthodox monetarist theory. So there’s a lot of emphasis on how they are not doing as well as other countries. Well, what about all those countries they are doing better than?

Why aren’t we seeing so many economists saying Switzerland or France or Portugal are in a “lost decades”?

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.